CPI throws spanner in works of November cut

Wednesday’s inflation numbers have thrown a spanner in the works of a November rate cut.

The core inflation result for the third quarter of 0.75 per cent (average of the trimmed mean and weighted median) was materially higher than the consensus estimate of 0.60 per cent (see below for more).

Market forecasts were heavily skewed to the downside, with some economists anticipating a 0.4 per cent core print.

Only one analyst, HSBC’s Paul Bloxham, picked it with his 0.8 per cent core number.

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Interestingly, the first-quarter core inflation number was revised up to 0.65 per cent, which means core inflation in Australia (gross of any carbon effects) has expanded at a 2.8 per cent annualised pace over the first half of the year. This is well above economists’ estimates and in the top half of the Reserve Bank’s target band.

It is worthwhile noting the RBA’s target 2 to 3 per cent band is high by international central banking standards. The Aussie dollar rallied from a low on Wednesday of 102.57 US cents to hit 103 US cents during trading.

Wednesday’s inflation report is vital to the RBA’s November board meeting. And neither financial markets nor economists were prepared for a high number.

According to the latest Bloomberg poll, 23 of 27 forecasters are predicting Australia’s central bank will cut its official target cash rate for the second month in succession on Melbourne Cup day, back to its record low of 3 per cent, which was last touched in April 2009. This would preserve governor Glenn Stevens’s perfect track-record of shifting the cash rate on every single Melbourne Cup day since he was appointed in 2006.

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With iron ore prices 35 per cent above the worrying September 4 threshold that compelled the RBA to pre-commit to a cut, Australian share prices up 9.9 per cent in the past three months (and 12 per cent in the year-to-date), auction clearance rates way above 2011 levels, and consumer and business confidence improving, the main reason the RBA will pre-emptively ease again is if core inflation is weak enough to warrant such action.

Wednesday’s results imply that core inflation has been running in the middle or possibly top half of the RBA’s target band over the past six months.

One wrinkle this quarter is the need to strip out the carbon price effects. Since a lot of the big price moves are automatically removed from the two main core inflation measures (the so-called “trimmed mean" and “weighted median"), the residual impact is believed to be relatively modest at about 15 basis points.

As my second chart shows, the vast bulk of forecasters were punting on soft prints. Indeed, two – Macquarie and BNP Paribas – expected core inflation to be a stunningly low 0.4 per cent. This would have opened the door to a 50 basis point cut in November.

A further 16 (or 18 in total) anticipated that the trimmed mean benchmark was going to be 0.5 or 0.6 per cent, which would have been tepid enough for the RBA to go.

A little more remarkably, only one analyst, HSBC, expected core inflation to get anywhere near the levels – say 0.8 per cent or more (including carbon effects) – that would give the RBA pause.

The futures market was pricing in an 80 per cent-plus probability the RBA will furnish more rate relief in November. After Wednesday’s inflation data, this fell to around 65 per cent.

Prior to the release, the head of Asia-Pacific research at TD Securities, Annette Beacher, commented: “Core inflation of 0.8 per cent or more will push annual inflation straight back to the RBA’s mid-target at around 2.4 per cent, and we suspect the “consensus" will lose enthusiasm for a year-end rate cut, shifting the timing into the first quarter of 2013. This would be clearly Aussie dollar positive and the short end of the yield curve would sell off aggressively [with bond prices falling and yields rising]. However, we do not place much weight on this scenario at all."